Thailand – winds of change

The Star Online

Saturday July 12, 2008

By KFH RESEARCH

THAILAND’S economy accelerated in the first quarter of 2008 as the first elected government since the coup in 2006 took office, underpinning a rebound in consumer confidence and spending. GDP growth for 1Q08 came in at 6% y-o-y (1.4% q-o-q), the fastest growth in two years and higher than the 5.7% recorded in 4Q07.

The better-than-expected GDP result for 1Q08 partly suggests that restoration of a democratically elected government in early 2008 has provided a boost to consumer spending and investment, supported by the new administration’s pro-growth economic policies.

However, political stability still remains an issue, and the recent political tensions, which culminated in anti-government street protests and concerns of a coup, are expected to hurt investor confidence, already reflected by the downward slide in the country’s stock market.

In addition to concerns about political turbulence, rising oil prices are another source of worry for the Thai economy. High fuel costs are slowing the US$206bil economy, and the risk of inflation remains on the upside.

Inflation in May soared to the highest in a decade at 7.6% y-o-y. In view of the downside factors related to the global environment (oil prices and external demand) as well as Thailand’s political and policy environment, a slowdown in the upcoming quarters is highly likely.

Thus, we expect Thailand’s GDP to grow by a revised forecast of 4% – 4.5% in 2008, compared to 4.8% in 2007. On May 23, Fitch Ratings affirmed Thailand’s long-term foreign and local currency Issuer Default Ratings (IDRs) at BBB+ and A, respectively, with outlook on the ratings remaining stable.

A strengthening external financial position, improving public finances, clearer and more stable policy environment, the restoration of democracy and the ongoing financial reforms all help to support the sovereign ratings.

Downside risks for domestic demand

Domestic demand, which picked up in the 1Q08 after having remained sluggish throughout 2007, was the key driver of growth during 1Q08, and is expected to remain bullish in 2008.

However, private domestic demand faces significant downside risks over the next six months as consumer sentiment is highly susceptible to politics and inflation.

Nonetheless, domestic demand is expected to drive growth in 2008. Consumer confidence began rising amid anticipation that a democratically elected government would pursue policies more designed to promote growth than those of the military junta it replaced.

Private consumption rose 2.6% from a year earlier, following the government’s economic stimulus measures. While the 2.6% y-o-y rise in consumer spending was still weak by historic standards, it represented the biggest gain in five quarters.

The Consumer Confidence Index rose to 79.9 points in April 2008 from its low of 75.5 points recorded in October 2007, signalling a regain in confidence amongst consumers.

Similarly, an encouraging 5.4% y-o-y increase in investment provided key support to the Thai economy in the quarter.

Although the new government elected in early 2008 brought the democratic process back in place in Thailand’s political landscape, the political scene since has not been without tension.

In May 2008, protestors led by People’s Alliance for Democracy (PAD) movement, took to the streets to demand the resignation of Prime Minister Samak Sundaravej and his coalition government, following their plan to amend the present constitution. Political tensions continue to remain high.

Impact of political uncertainties

Expectations are that the new government will pave the way for clearer policies, but political instability could potentially delay the recovery of private investments and household consumption.

Continued social and political unrest in the central and southern provinces of Thailand could halt funds inflow and serve as a potential drag on overall economic sentiment. It is encouraging that the Business Sentiment Index moved up to 43.0 points in April 2008, from a low of 39.3 points the previous year, as this reflects an improved investor perception.

However, political instability after prolonged street protests by PAD in May and political uncertainties moving forward could cause Thailand to lose foreign-investment attractiveness.

So far, FDI has not been impacted by the political turmoil, as the value of investment projects approved by the Board of Investment rose 10% y-o-y in the first four months of 2008. However, if the political uncertainties continue, new investment for full year could be affected.

Investments by the private and public sectors as well as household consumption should pick up from the low rates last year.

In 2007, domestic demand remained in a slump, growing at only 1.7% y-o-y, as a result of sluggish private consumption growth and a contraction in private investment, according to the World Bank.

As compared to other countries in the region, Thailand’s private consumption has remained relatively low as political uncertainties have impacted confidence levels.

Recovery in private consumption and investment could be fragile as there remain large downside risks to their growth, but could be mitigated by additional fiscal stimulus.

Risks to growth this year comes mainly from external factors such as the high oil and food prices and the potential significant slowdown in world economic growth.

On the domestic side, if uncertainties in policy directions return, such as from a change in government, consumer and investor confidence will be adversely affected. However, in the case that the global environment turns out to be more unfavourable than expected, Thailand’s strong fiscal and macroeconomic stance would be able to cushion some of the negative impacts. The government’s fiscal deficit and public debt are currently low at 2% and 38.5%, respectively. Foreign reserves have climbed to over US$90bil, or some four times short-term external debt. There is therefore room for additional fiscal stimulus if needed.

Fuel for inflation

On May 20, Finance Minister Surapong Suebwonglee announced that the government would increase spending to counter cooling economic growth as rising oil prices spurred inflation and potentially constrained consumer spending.

The government plans to spend 1.84 trillion baht (US$57bil) in its fiscal year starting October, a 12% increase from the forecast 1.64 trillion baht expenditure this year, helping the government meet its target of expanding the economy.

On the inflation front, headline inflation will likely rise to 5%-5.5% this year, which is an upward revision of our previous forecast of 3.5% on the back of soaring oil prices.

In April 2008, headline inflation hit a two-year high of 6.2% y-o-y, underpinned by rising costs for energy (+16.8% y-o-y or 3.2% m-o-m) and uncooked food (+14% y-o-y or 5% m-o-m).

Food inflation hit a 10-year high, with rice prices surging. Price controls on liquefied petroleum gas (LPG) will expire in July. Therefore, severe food inflation is expected to continue until at least August.

Other factors that may contribute to inflation are an average 5% rise in labour costs, as the minimum wage has been increased from June 1, and a tentative 13% increase in transportation fees.

Preliminary figures show that Thailand’s inflation rate in May soared to 7.6% y-o-y, the highest in nearly a decade, due to the unrelenting rise of oil prices. Risk to inflation remains on the upside moving forward.

The relatively upbeat national accounts data in the first quarter, coupled with upward pressure on consumer prices, increases the risk that the next interest rate adjustment by the Bank of Thailand will be upward.

We believe that the monetary authorities are not yet committed to such a move, as the core inflation rate remains a relatively subdued 2.1%. However, any significant pick-up in the June inflation figure would almost assuredly trigger a round of tightening at their next policy meeting in mid-July.

The rising Baht

We believe that given the current inflation targeting framework, monetary policy can take care of exchange rate as long as there is no conflict with inflation.

Foreign exchange market is intervened when there is too much volatility in the market. The objective is to smooth the country’s adjustment during the transitional period.

Looking forward, the baht movement will depend largely on external developments and also internal drivers: large surplus in current and capital accounts.

The Thai stock market remains one of the most popular destinations in emerging markets for foreign investors, given its relatively low P/E ratio. Such inflows together with foreign direct investments have also added pressure on the currency.

The baht will continue to appreciate as the balance of payments remains in surplus and the USD continues to depreciate. The baht continued to appreciate in 2007 by 9% compared to the USD.

In terms of the real effective exchange rate (REER), the baht has appreciated by 6.6% last year on top of 8.9% in 2006.

The baht’s appreciation was more than other currencies in the region except for the Philippines peso and the Indonesian rupiah. The baht’s REER should appreciate further this year as the balance of payments remains in surplus and the value of the USD continues to fall.

We believe the baht will appreciate to above 30 to a dollar in the near term. While the government is also expected to bring out new policies to curb baht appreciation, other near-term factors convince us that the outlook for onshore baht is positive. Thailand’s current account, which has been recording a surplus since mid-2006, posted its first deficit in 21 months in April, as surging oil prices increased the import bill to record highs.

For 2008, the surplus is expected to trend lower to 2.1% of GDP from 6.1% last year as Thailand’s trade balance is reduced substantially on the back of anticipated lower exports but higher import spending.

In 1Q08, exports of goods and services were up a solid 8.7%, but the increase was overshadowed by a 10.3% jump in imports.

Key risks for the Thai economy in 2008 include:

(a) An escalation of tensions in the southern region, which would derail efforts to boost FDI in the country,

(b) A drastic slowdown in global economic growth, which would inevitably reduce export growth,

(c) Political tensions or instability, which may erode investor confidence, and

(d) Persistence of high crude oil price or renewed hike, which would lead to high domestic retail oil prices and consequently spark higher inflation

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